Narrow Money

Last Updated :

21 Aug, 2024

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Table Of Contents

Narrow Money Definition

Narrow money is all the physical or liquid form of money circulating in an economy. Typical examples of money that fall under this category include paper currency, coins, demand deposits, and other checkable deposits. It is a key indicator of money supply in an economy and hence paves the way for determining a nation’s economic performance.

Its primary advantage is that it facilitates immediate monetary transactions and hence is a key measure of the purchasing power of people in an economy. Tracking narrow money helps authorities regulate the overall money supply in the economy through its monetary policies. Narrow money is just one end of the total money supply spectrum. The other is broad money which includes less liquid financial assets.

Narrow Money Definition

Narrow money, referred to as M0 and M1, is the most liquid form of money, including notes, coins, and demand deposits.
Typical applications of narrow money include paying in currency, writing checks, or ATM withdrawals from savings accounts for commercial purposes.
Its most important feature is that it is easily accessible for commercial transactions.
It facilitates monetary authorities to formulate policies that ensure a balance between inflation and economic growth.

Narrow Money Explained

Narrow money is a component of the money supply that includes only the most liquid form of money held by the public in an economy. It comprises notes, coins, and all the deposits that individuals have in their bank accounts. However, note that foreign currencies don’t come under this category.

It has no alternative in day-to-day life transactions. No other class of money comes closer to beating narrow money concerning its immediate usage, whether paying cash for commodities or writing a check for an employee. This ease of access makes it highly liquid.

In a real-life scenario, any form of immediate currency used to make purchases will be considered narrow cash. It does not matter whether it is in the pocket, bag, or under the couch. The key thing here is that the money is in circulation, and it does not matter if the money goes to someone else after making purchases.

Note that demand or checking deposits that people hold in their bank accounts fall in this category. This is because people can easily withdraw them on-demand or write a check to make payments. It makes them as liquid as coins and notes, earning them the right to fall under this class.

Components of Narrow Money

Monetary authorities segregate the total stock of money into monetary aggregates to measure the money supply in an economy. They are labeled as MB/M0, M1, M2, and M3.

Monetary base (MB/M0) = Currency in circulation + Federal reserve balances

M1 = Currency + Demand deposits + Other checkable deposits

M2 = M1 + Term deposits

M3 = M2 + Large term deposits (not measured by federal reserve anymore)

Components of narrow money include all elements of MB/M0 and M1.

Examples

Example #1

John is going for a ride with his friends, and suddenly, he sees an ice-cream parlor. He pulls out the requisite cash from his wallet and makes immediate payment to the ice cream parlor. However, on other occasions when he forgets to carry cash in his pocket, he makes up for it by going to the ATM and withdrawing the required amount from his savings account for ice cream using his debit card.

In both cases, narrow money is in operation. The first case was a case of a highly liquid transaction involving notes or coins, while in the second case, it took just a bit of time to encash because of the involvement of demand deposits (withdrawing money from a savings account).

Example #2

Recently, the Russian invasion of Ukraine has brought about a sharp rise in global crude oil prices. However, Nigeria is not likely to benefit from the surge due to its limited crude oil production.

While rising crude oil prices may leave more money in circulation, it will also put pressure on foreign reserves and exchange rates to meet the demands of the higher cost of imported oil. On the one hand, this will increase narrow money as more money will be in circulation due to rising oil prices. But on the other hand, a depleted foreign reserve may terribly affect Nigeria's gross domestic product (GDP).

With such pressures mounting on the Nigerian economy, Nigeria is lingering on inflation and depreciation of its currency Naira against the dollar. It is a classic case of how an increase in narrow money can lead to inflation if not coupled with a positive GDP growth rate.

Narrow Money and Broad Money

Broad money constitutes a larger segment of the money supply comprising of both liquid and non-liquid money. It includes all components of M2 and M3. It usually consists of deposits that take more than 24 hours before they reach maturity for transactions.

At the same time, narrow money (M0 and M1) forms a small part of the money supply. Unlike broad money, which takes longer to mature, users can use it for instant transactions because of its liquidity.

While narrow money presents a smaller picture of the economy’s health, broad money is the most comprehensive method to calculate the total amount of money in an economy. This is because it includes liquid money plus all other assets that are convertible into cash.

A simple example of broad money would be mutual funds. Mutual funds can’t be converted to cash until they reach maturity, which may be six months or six years, depending on the chosen scheme. Converting shares into cash is another classic example of broad money usage.

Narrow Money	Broad Money
Liquid money circulating in an economy that is available for immediate transactions	Financial assets that usually take more than 24 hrs to convert to cash
Generally referred to as M0 and M1	They are denoted by M2 and M3
Can be trusted for emergency transactions.	Can’t be considered a means for emergency transactions as they take time to mature
Provides a narrow vision of money supply within an economy	Provides a much broader spectrum of money supply within an economy
Examples include notes, coins, and demand deposits	Examples include deposits that take time to mature, such as mutual funds, bonds, and stocks

Importance

Narrow money shows the status of money supply within an economy. Though limited in measure, it goes a long way in determining the overall economic health of an economy. It is because it reveals the purchasing power of people, which is directly related to demand and inflation.

Besides, the money supply also has a strong relationship with economic activity. Therefore, if the money supply is not regulated, it may result in inflation and higher prices. Thus, monetary authorities try to make a trade-off between inflation and economic growth by controlling the money supply through effective monetary policies.

Hence, measuring narrow money aids policymakers in predicting and controlling inflation and rising interest rates. However, the federal bank does not entirely depend on money stocks to formulate and implement its policies. Rather, it also pays attention to interest rates to carry out its policy implementations.

Frequently Ask Questions (FAQs)

What is narrow money?

Narrow money refers to a class of money that is liquid or physical and is readily available for monetary transactions.

What is the difference between narrow and broad money?

Narrow money is already highly liquid and can be used immediately for financial transactions, such as paper currencies filling your wallet. On the other hand, broad money takes a long time to reach maturity or be encashed. A typical example of broad money is bonds which take a long time to mature.

What are some examples of narrow money?

· Any note or coin in the wallet, pocket, etc.
· Paying someone in a check that can be encashed in a bank
· Using an ATM or debit card to withdraw any amount of cash from checking accounts

What are M0, M1, M2, and M3 used to denote?

These are monetary aggregates that are used to measure the money supply in an economy. M0 and M1 represent narrow money, whereas M2 and M3 indicate broad money.